Against the Grain

NOV

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As discussed in last week’s blog about spin-off opportunities, ATG will be taking a position in a recent spin-off company. That company is NOW Inc., (ticker DNOW), a $3 billion market cap oil services distribution company based out of Houston that spun-off from the $30 billion market cap National Oilwell Varco (NOV) back in May 2014.

When looking at spin-offs, the first question to ask is this- who’s likely to win from a spin-off… the former parent company or the new spin-off?? While not always a zero-sum game, it’s the question that I suppose separates the men from the boys in the world of special situation investing. In this case, I have a hard time coming to any strong opinion on the matter- National Oilwell Varco has been one of my favorite personal stocks for a while. After all, NOV’s long-term dominance in providing equipment and components to all phases of the oil and gas industry has earned them the nickname of “NOV- No Other Vendor”. Market leader, attractive P/E (10.5), low leverage, good return on equity (12%), solid earnings history… it has virtually all the traits that I covet when owning a stock.

According to the Form 10-12B filed in February, 2014 (Form 10’s are the formal notification documents when public companies intend to issue additional securities via IPO’s, secondary offerings, spin-offs etc.), NOV decided to spin their $3 Billion distribution arm off so that the separate entities could better focus on their particular niche and respective specialties- NOV as a drilling rig parts supplier and DNOW as a supply chain/ distribution provider to the oil and gas industry.

DNOW’s distribution arm has tended to be a lower margin business as compared with NOV’s main operations- by shedding DNOW they can improve their margins in hopes of getting a higher multiple on their stock. On the flipside, a separate distribution company for DNOW allows them to leverage dominant distribution channels and market product for new suppliers in addition to NOV.

Since the spin-off, both NOV and DNOW have had a similar trajectory, albeit that DNOW has been a tad more volatile, reaching gains north of 25% before dropping to 5% below their spin-off price in light of the recent oil price slide:

While I have a hard time coming up with reasons to knock the long-term opportunity of NOV, ATG ultimately made the decision to buy DNOW instead of NOV for the following reasons:

Merill Miller, the long-time CEO of NOV primarily responsible for their evolution into the dominant market leader for oil services stepped down from NOV in November 2013 in order to lead and serve as executive chairman of DNOW.

DNOW has effectively no debt on its balance sheet despite a well-established, profitable business. There is tremendous opportunity for accessing cheap capital to pursue growth opportunities.

As a $3 billion company (vs. NOV at $30 billion), DNOW has a larger runway for long-term growth prospects, particularly given the opportunity for them to market product from new suppliers.

The cyclicality of oil-related businesses and the glut of oil supply in the world today are serious risk factors in the near and medium term, but NOW feels like a good time to pick up a quality spin-off opportunity in DNOW for the long haul…